Sunday, January 29, 2006

Disrupting the VC Industry: a VC investment Market

The discussion about disrupting the VC business hit the blogsphere late last week. Primarily driven the posts by Rick Segal and Doc Searls. A pause of a few days and Dave Winer has proposed User Internet Capital Corp to disrupt the VC business. Doc Searls has thrown support behind the idea as well. When the conversation was first begun, I thought about how the industry could be distrupted. I must admit that I am disappointed by what has been proposed. In a sense the User Internet Capital Corp is simply a VC fund open to all and sundry.

A more disruptive idea is to create a VC market. A market where people (users included) can invest in high risk/high growth businesses from an early stage. A market for Venture Capital would be far more disruptive than simply creating another form of the VC.

So how would the market work? A company would register with the market. The registration process would include the necessary due dilligence process that provides the basis for trust within the market. The company would then place a certain number of shares up for auction.

The auction process would work like this. Bidders bid not only a price but also an amount of shares they wish to buy at that price. At the close of the auction, the highest bidder pays the amount they bid and receives the corresponding number of shares that they bid for. If the highest bidder did not buy all the shares then the remain shares are offered at the final bid price to the other bidders.

An option is available where the total amount of a final bid (bid price for shares x the number of shares wanted) of losing bidders will be divided by wining bid price and they receive that number of shares. The shares that people purchase can then be traded within the market. The last traded price for a company's shares becomes the starting price if a company decides to do another round of funding.

Anyone can register to bid. The registration process for bidders is again a due dillegence process that provides the bid side trust for the market. There is no minium amount or number of shares that a registered bidder can bid for. If all they want is one share , then that is all the need to bid for.

A VC investment market opens up investment in high risk/high growth to anyone (Doc Searls and Dave Winer's users) businesses. A far greater number of businesses will be able to seek and receive VC funding than through the current method. The risk of any individual investor can be spread even further. It also brings competitive bidding to the process which will bring their own improvements to VC investment. Finally, it opens VC investment to the wisdom of the crowds which brings with it the possibility of better selection of great ideas.

I really think that a VC market will produce far greater disruption of the VC investment industry than the creation of a publicly traded VC fund as Dave Winer has proposed.

Links to Conversation:
Michael Parekh
, Paul Kedrosky, Mathew Ingram, Michael Arrington, Mark Evans, Robert Scoble

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Anonymous said...
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Fraser said...

Hi Simon,

Interesting post - I just came across it now, so excuse the tardy comment :)

Is there a reason you propose executing the auction the way you describe? It sounds very close to a dutch style auction (I understand there are differences between the two, but the principle is close). Just wondering if there was a specific reason for your method.

Are you familiar with the concept of Capital Pool Companies? (Check them out here)

The concept of CPCs contain similar elements to your idea and allow new ventures a different option to help bridge the gap between start-up and IPO.

Curious to hear your thoughts on CPCs.

Fraser said...
This comment has been removed by a blog administrator.
Simon Cast said...


The method I proposed was designed to meet to goals: first raise as much cash for the company for as little equity (also control) as possible and also allow smaller investors a chance to purchase shares in a small company even if they do not have a winning bid.

CPCs sound like a reasonable idea but they would not be applicable to every situation. My understanding (admittedly only after reading the brochure) is that it is vehicle for small cap buyout. This will not suit all startups where the founder wants to retain significant control.

I have doubts about whether a CPC would be a suitable method for raising capital for a developing tech company. CPCs seem to be better for small companies that have plateaued have revenue and cashflow but without an injection of capital are not going to see significant revenue growth. The companies I am thinking about are a manufacturing operation that has a reasonable offering but needs cash for expansion and the founder wants to retire. Basically a sound SME business that needs a capital injection but is not suitable for IPO.

One thing from the brochure that did stand out was the low (33%) of CPCs that went onto the main exchange. Whether this is because they never pass the cap requirements for the main exchange or are just not going anywhere would be interesting to find out.

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